Funds and how they work

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The investment company that sponsors a mutual fund sells shares
to investors and then invests the funds that are received in a portfolio
of securities. By pooling investors’ funds, a fund manager can
diversify the purchase of different securities, such as stocks for
stock funds and bonds for bond funds. The objectives of a fund
determine the types of investments chosen. For example, if a stock
fund’s objective is to provide capital appreciation, the fund invests
in growth stocks.

Dividends from stocks in the portfolio are passed through to
the fund’s shareholders (as dividends from the fund). An investor
who invests $1,000 gets the same rate of return as another investor
who invests $100,000 in the same fund, except the latter shareholder
receives a dividend that is 100 times greater (proportionate to the
share ownership in the fund).

When prices of securities in the portfolio fluctuate, the total
value of the fund is affected. Many different factors—such as the
intrinsic risk of the types of securities in the portfolio, in addition
to economic, market, and political factors—cause these price fluctuations.
The fund’s objectives are important because they indicate
the type and quality of the investments chosen by the fund. From
these objectives, investors can better assess the overall risk the fund
is willing to take to improve income (return) and capital gains.
Investment companies offer four different types of funds:
* Open-end mutual funds
* Closed-end funds
* Unit investment trusts (UITs)
* Exchange-traded funds (ETFs)—ETFs are mostly sponsored
by brokerage firms and banks.